PDF Summary:Getting Started in Technical Analysis, by Jack D. Schwager

Navigating the intricacies of financial markets can be a daunting task. In Getting Started in Technical Analysis, Jack D. Schwager equips you with essential techniques and strategies for analyzing market trends and patterns. From understanding different chart formats to identifying reliable signals for entering and exiting trades, this guide offers a comprehensive approach to conducting technical analysis.

Schwager delves into the practical aspects of trading, covering risk management, system development, and the psychological nuances that distinguish successful traders. With insights gleaned from seasoned professionals and meticulous backtesting methods, this book empowers you to formulate a systematic trading plan tailored to your goals and risk tolerance.

(continued)...

Incorporating flexible stop-loss orders into exit strategies can secure profits while permitting profitable trades to persist.

Establishing predetermined profit objectives can secure earnings, yet it might also result in exiting an investment prematurely when it still holds considerable potential for appreciation. Schwager advises using flexible stop-loss orders to pinpoint the best time to exit an investment, emphasizing their usefulness even though they may not be exciting.

To safeguard the value of investments, the placement of stop-loss orders is methodically modified to reflect positive changes in price. In a rising market, the stop level for a long position is progressively raised, while in a declining market, it is correspondingly lowered for short positions. Traders can secure a considerable share of a beneficial price shift while mitigating the risk of forfeiting substantial gains by setting up protections against a trend's change in direction.

Chapter 9 details various methods for setting trailing stops. The basis for establishing a stop level may encompass factors like market movements, the breadth of trade operations, and a variety of patterns discerned within graphical market representations. An order to stop can be triggered to execute when the market price drops by a specified dollar amount or percentage.

Determining the appropriate scale for trade positions involves managing risk.

Successful trading is built upon the effective management of risk. A seemingly profitable approach can quickly lead to disaster in the absence of a clearly established risk management plan. Schwager emphasizes the critical role of stringent loss control strategies as a cornerstone of profitable trading.

Implementing a strategy that limits potential losses by setting a maximum risk level for each trade.

An essential element of risk management is to establish a limit on the potential capital loss in any given trade. Schwager recommends limiting potential losses to no more than 1-2% of one's total capital. He recommends capping the risk for any single trade to a maximum of 3% of the entire capital.

Traders should determine the appropriate size of their investment by taking into account their capital and the expected price at which they plan to enter and exit the trade to limit losses. The difference between the entry price of the trade and the stop-loss price establishes the possible loss for each share or contract.

A trader with a portfolio of $100,000 who caps their risk at 2% per trade, which amounts to $2,000, can buy 400 shares and establish a safety threshold to sell the shares if they fall by 5 points from the buying price. A market participant engaged in futures might decide to acquire three corn contracts with an account of the same scale and comparable risk tolerance, establishing a predetermined point for cutting losses by selling if the price dips 20 cents under the entry price.

Automatic orders designed to cap potential losses are intended to terminate a trade if the market trends unfavorably to a predetermined degree, activated when a particular price threshold is met. They are essential in successfully finalizing trades and in preventing catastrophic financial consequences. Schwager recommends that traders bolster their discipline through the use of stop orders, which stay in force until they are carried out or cancelled.

The reliability of stop-loss orders can be compromised by slippage, especially during volatile market periods or when liquidity is scarce. They serve as an essential safeguard for mitigating losses and protecting investment funds.

Adjusting the level of leverage based on market volatility shifts, fluctuations in account size, and insights gained from experiencing a sequence of losses.

Investors must also take into account their total exposure to risk, which can be affected by changes in market volatility, the size of their trading account, and their track record during streaks of losses.

The volume of traded shares or contracts should be adjusted based on the current market volatility. To maintain a consistent level of risk, one must adjust their strategy by utilizing lower leverage in markets with greater volatility. In a market with lower volatility, a trader may opt to trade using four contracts, while in a market with higher volatility, they may limit their activity to a single contract, following a rule that caps the risk at no more than two percent of the trade's value.

Modifications to the degree of financial leverage ought to coincide with shifts in the account's worth. As the value of the account decreases, it is wise to proportionally reduce leverage in order to maintain the established level of risk. If a trader's capital reduces by 20%, they should prudently reduce their leverage in proportion, assuming the volatility in the market remains consistent.

When traders face multiple setbacks, it may be wise for them to consider scaling back on the size of their trades or taking a break from trading to understand the causes of their losses and regain their confidence. Schwager notes that reducing position size during losing periods is a common strategy among successful traders.

Other Perspectives

• While percentage-based retracements can be a useful tool, they may not always accurately predict market movements, as markets can be influenced by a multitude of unpredictable factors.
• Moving averages and pattern breakouts are lagging indicators and may not always provide timely signals for initiating trades, potentially leading to missed opportunities or entering trades too late.
• The strategy of waiting for a 35% to 65% retracement may result in missed trades if the market does not retrace to the expected level, or it may lead to entering a trade just before a reversal.
• Predicting minor pullbacks and resuming trades can be challenging in highly volatile markets where false signals are common, leading to increased risk of losses.
• Flags and pennants, while often reliable, are not infallible indicators of trend continuation and can sometimes precede trend reversals.
• Timing market entries is inherently difficult, and even with careful analysis, traders can still experience significant losses due to unexpected market events.
• Using historical examples like the coffee prices in 1994 to emphasize risks may not always be applicable to current market conditions, as markets evolve over time.
• Setting profit targets based on chart patterns assumes that historical price movements will repeat themselves, which may not always be the case in an ever-changing market.
• Indicators such as RSI and stochastics can provide false signals in trending markets, leading traders to exit profitable trades prematurely or to hold onto losing trades for too long.
• Flexible stop-loss orders can sometimes lead to premature exits in volatile markets, where temporary price spikes can trigger the stop-loss.
• Trailing stops may not always protect profits effectively, especially in markets with sudden large moves that can gap past the stop level.
• Limiting potential losses to a fixed percentage of total capital can be too rigid and may not account for the specific risk profile of a given trade or the trader's overall strategy.
• Adjusting trade size based on capital and stop-loss levels does not take into account the quality of the trade setup or the current market context.
• Adjusting leverage based on market volatility assumes that past volatility will predict future risk, which may not always be the case.
• Reducing leverage during losing streaks can be a prudent strategy, but it may also prevent traders from taking advantage of high-quality trade setups that may occur during such periods.

Developing and assessing trading methodologies

These methods are based on detecting strategies and patterns that deviate from or conform to the current market direction.

Distinctive benefits and drawbacks are inherent to every system type.

Trading strategies are composed of definitive rules that generate signals for transactions, based on technical analysis, patterns in charts, or economic indicators. They eliminate subjective influence when executing trades, ensuring consistent implementation of the selected strategy. Schwager categorizes trading methodologies into three primary categories: those that leverage ongoing market movements, those that predict shifts in market directions, and those that discern and analyze configurations.

Systems that follow trends aim to capitalize on existing market movements by starting trades that correspond with the ongoing directional force. They rely on indicators that suggest a possible change in the current market direction, such as when moving averages cross, prices break out from a consolidation phase, or the rate of price movements alters. Their strength lies in capturing large profits on sustained trends but can generate false signals and whipsaw losses in choppy or sideways markets. The structure is primarily aimed at maintaining consistent engagement in the market.

Systems that counter the prevailing market trend seek to benefit from buying at reduced rates and selling at elevated levels by challenging the established trend in market prices. They identify periods when the market shows a strong inclination and initiate trades in opposition to this tendency, expecting a future market correction. They utilize metrics that reflect the market's current sentiment, often clashing with the widely held beliefs of the moment. They might benefit from short-term price volatility, yet they also face the possibility of unlimited losses if the market experiences sustained trends in one direction. Stops are generally essential for countertrend systems.

Systems that pinpoint specific shapes on trading charts, like the head-and-shoulders formation, double peaks or troughs, pennants, and market voids, aim to recognize unique visual indicators that indicate the most favorable times to start or exit trades. The success of these methods depends on the trader's ability to identify and comprehend these patterns. Proficiency in interpreting chart formations frequently assumes a more critical function in these strategies, which generally prefer a subjective method over rigidly following or contradicting current market movements.

To enhance the effectiveness of the foundational system, one might incorporate filtering techniques, establish criteria for verification, and employ flexible approaches for determining position sizes.

The creation of trading strategies can be based on employing the intersections of simple moving averages or when prices fluctuate outside of established boundaries, despite their core efficacy often not meeting anticipated outcomes. Investors can enhance their performance and mitigate potential risks by employing a variety of strategic modifications.

By discarding trades considered to have a diminished likelihood of success, the effectiveness of trade signals is improved. A system created to track trends might include features that ignore specific signals, especially if these signals arise during market fluctuations that fall within a set range or if they conflict with the dominant long-term direction indicated by a slowly evolving moving average.

To minimize the risk of responding to incorrect signals, a trade signal must meet additional conditions before being deemed suitable for trade execution. For instance, a breakout-focused strategy may require prices to remain consistently higher than the breakout point for a set duration prior to making a buy, or an approach that relies on moving average crossovers might postpone the purchase until the price has risen by a specific percentage from the crossover point.

Strategies that dynamically adjust the size of trades consider market conditions, the trader's risk tolerance, and fluctuations in the trading account's value, alongside the track record of the strategy used. Pyramiding, discussed in Chapters 8 and 14, is a common approach that allows traders to increase their position size as the market moves in their favor, maximizing profits on large trends. In times of heightened fluctuations in the market or when facing a string of losses, it might be wise to reduce the size of trades to better control overall risk.

Assessing how well a system functions by optimizing and running simulations.

Recognizing the risk associated with excessively tailoring systems to fit past data.

Traders must backtest their trading system by analyzing past market prices to assess its likelihood of success. This involves performing assessments to determine how the system has performed historically under past market circumstances. Basing system evaluation on only the highest-performing parameter sets from past data can result in inaccurate conclusions.

Schwager cautions that frequently attempting to optimize a system can lead to an overestimation of its potential success, sometimes to a considerable degree. Price movements exhibit a significant level of unpredictability. Choosing a specific combination of parameters due to their past performance might be accidental and does not guarantee similar outcomes in the future. He emphasizes that fine-tuning the parameters of a trading strategy may give the illusion of remarkable effectiveness when looking back.

Approaches that ensure impartial and precise assessments of a system's performance, including the execution of tests without prior knowledge and the aggregation of results across various parameter settings.

Traders must employ more rigorous evaluation techniques to precisely determine the capability of a system and avoid the pitfall of overfitting. Schwager recommends assessing effectiveness through unbiased experimentation and examination of mean results over a range of parameter configurations.

The parameters of the system are meticulously adjusted using past data, except for the most recent dataset, which is then evaluated using the parameters that were determined to be the most effective from the data that was reserved initially. This technique permits iterative use, utilizing different segments of the data for improved analysis and meticulous adjustments. To minimize the risk of data snooping bias, it's essential to use different periods for optimization than those employed for validation.

The approach involves assessing the system's performance across a range of parameter values and calculating the average outcome for all the different scenarios examined. By steering clear of the hindsight bias that comes with selecting the most favorable settings, a more cautious assessment of what the system might achieve is accomplished.

Practical considerations for system development must also include thorough evaluation through testing.

Choosing suitable pricing information and relevant time periods

Assessing the success of trading strategies requires careful attention to a variety of practical details to ensure that the results are reliable and reflective of real-world trading conditions.

Selecting the appropriate market data is essential. Traders in the stock market can utilize a wide range of historical pricing data that includes modifications for share divisions. Market participants engaged in futures trading can choose from various options, including data on particular futures contracts, the contract with the nearest expiration date, or a combination of contracts to form a continuous sequence. Schwager recommends consistently incorporating a flow of information on futures when evaluating systems to accurately reflect market movements and to avoid the possible misrepresentations that can occur in the charts of the most immediately expiring futures contracts. Systems concentrating on short-term intervals could also gain advantages by incorporating insights from existing contracts.

The assessment period must encompass a variety of market conditions, but should not extend to such a length that it becomes disconnected from current market trends. Schwager suggests that while most strategies should be tested over ten to twenty years, he concedes that strategies intended for brief trading intervals may require a lesser validation period.

When choosing performance metrics, it is essential to select measures that provide a comprehensive view of the system's earnings potential and its vulnerability to possible monetary setbacks. When evaluating, it is crucial to take into account several important metrics such as the return on investment, the maximum drawdown, the balance between risk and reward, consistency across different periods, and adaptability to changing market conditions.

Utilizing chart analysis and programming skills to create, examine, and refine methods for executing financial market transactions.

Modern instruments for plotting and examining market trends greatly assist in developing and assessing trading approaches. These tools assist traders in setting benchmarks for transactions, organizing price information for various analytical aims, and creating visual displays that highlight indicators for optimal trade timing. Gaining proficiency in these tools is essential for those who are developing their personal trading strategies.

Possessing programming skills greatly expands an investor's options when devising their approach to market transactions. A deeper understanding of software and programming leads to the creation of trading strategies that are increasingly complex and advanced.

Other Perspectives

• While trading strategies often use technical analysis and chart patterns, critics argue that these methods can be subjective and may not consistently predict future market movements due to the complex and dynamic nature of financial markets.
• The categorization of trading methodologies might be overly simplistic, as many strategies incorporate elements from multiple categories or use hybrid approaches.
• Trend-following systems can be prone to significant drawdowns during market reversals, and critics argue that they may not adapt quickly enough to changing market conditions.
• Counter-trend systems can be risky, as they often go against the prevailing market momentum, which can continue for longer than expected, leading to substantial losses.
• The effectiveness of chart pattern recognition systems is debated, with some arguing that patterns may not be as reliable as statistical or quantitative analysis.
• Filtering techniques and flexible position sizing can add complexity to a trading system, potentially making it more difficult to execute and manage.
• The process of discarding trades with a diminished likelihood of success can introduce bias and may result in missing out on profitable opportunities.
• The requirement for additional conditions before executing a trade signal can delay entry into the market, possibly resulting in missed opportunities or entering a position too late.
• Dynamically adjusting trade sizes based on market conditions and risk tolerance can be challenging to implement correctly and may lead to over-leveraging or under-leveraging positions.
• Over-optimization is a valid concern, but the counterargument is that with proper validation and out-of-sample testing, one can mitigate the risk of curve-fitting.
• Impartial and precise assessments are ideal, but in practice, they can be difficult to achieve due to biases and the limitations of historical data.
• The selection of pricing information and relevant time periods for system evaluation can significantly influence the perceived performance of a trading system, and there is no one-size-fits-all approach.
• While chart analysis and programming skills are beneficial, they may not guarantee success in trading due to market unpredictability and the potential for over-reliance on technical indicators.

Strategies and advice for engaging in actual trading scenarios.

Formulating a methodical and organized approach for carrying out trade executions.

Developing a customized strategy for participating in financial markets.

Schwager emphasizes that market success demands more than simply having strong strategies for trading. To achieve success, it is essential for traders to adhere to a systematic and well-organized approach. Formulating a coherent approach to trading starts with selecting markets and developing a philosophy that are in harmony with one another.

The underlying principles guiding your market engagement are shaped by your approach to trading. Are you planning to adopt an approach that capitalizes on extended movements in market values? Do you have a tendency to take advantage of market volatility by buying at dips and selling at peaks, essentially acting contrary to the dominant market direction? Are you inclined towards a strategy that focuses on specific patterns in the configurations of charts to indicate possible trading opportunities? Selecting a trading approach that complements your individual traits, capacity for risk, and available time is crucial.

Selecting an appropriate market is of equal significance. Choose trading arenas that complement your strategic approach and level of expertise. For example, as someone who adheres to trend-following principles, your focus would be on markets that exhibit strong and sustained directional movements, while if your approach is based on trading against the prevailing trend, you would look for markets that show regular and predictable price oscillations. When selecting markets for focus, one must consider factors like diversification and the likelihood of price volatility.

Developing a consistent routine in trading practices and integrating strong risk management strategies.

To attain profitability in trading, one must not only develop a trading philosophy and choose appropriate markets but also rigorously apply risk management tactics and maintain a consistent trading routine. In his book, Schwager consistently underscores the critical role that rigorous risk control plays in attaining trading success.

He recommends developing a solid plan to swiftly limit losses from the moment a trade begins and advocates for investing a small portion of the total capital into any individual trade, ideally limiting it to no more than 3%. Diversifying investments among various markets and employing a range of strategies is crucial for reducing risk and fostering steadier investment growth. Traders should calibrate their leverage based on the volatility of the market and the magnitude of their trading capital.

Developing consistent habits in your trading behavior can enhance discipline and ensure commitment to your chosen strategy. This routine might include updating charts and honing trading tactics daily; reevaluating existing investments with adjustments to the parameters for securing profits and limiting losses; planning future trades based on analytical insights; maintaining a detailed log of all market transactions and their outcomes; and consistently reviewing your trading diary and pattern charts to learn from all trades, successful or not.

Developing key psychological and behavioral traits

Maintaining independence, confidence, and patience in decision-making

Achieving regular profitability in trading is as dependent on the mental approach as it is on the execution of a robust trading strategy. Schwager highlights the traits commonly observed among prosperous traders.

It is crucial to preserve independence while participating in transactions within the financial markets. Formulate your own evaluations rather than simply embracing the consensus. The observations made by Ed Seykota indicate that the prominence of a trading idea on the covers of popular magazines often signals that the idea's relevance is nearing its end. Rely on your personal assessment and decisions, and be guided by your individual insights.

Another crucial characteristic is self-assurance. Traders who achieve success persist in their belief in the possibility of success, even when they go through periods where their earnings temporarily decrease. They steadfastly maintain their strategic approach, remaining true to their pre-established path, regardless of unforeseen market movements.

Maintaining discipline is essential not only in identifying the best moments to trade but also in ensuring that profitable trades are given the opportunity to fully mature. Do not try to interact with every market movement or put in excessive effort to achieve that. The most promising opportunities frequently seem clear and easy to recognize.

It is essential to avoid common emotional traps and cognitive biases to improve trading performance.

Traders must not only cultivate positive traits but also deliberately avoid typical emotional hurdles and psychological traps that could negatively impact their trading results. Among these potential drawbacks are:

• Loss aversion: People frequently hold on to losing investments for too long, while quickly letting go of profitable ones, as the pain of a loss usually outweighs the pleasure of a comparable profit.
• Confirmation bias: Seeking out information that confirms your existing beliefs and discounting information that contradicts those beliefs.
• Overconfidence: Excessive self-assurance regarding one's trading abilities and neglecting possible risks may result in heightened use of leverage or an uptick in the frequency of trades.
• Hindsight bias: Attributing a higher degree of predictability to past events than they truly possessed led to an inflated confidence in forecasting future outcomes.
• Fear of missing out (FOMO): The apprehension of missing opportunities often leads to initiating transactions at unsuitable moments and taking on disproportionately large stakes.

Schwager underscores the necessity of recognizing and reducing such biases to guarantee decisions in trading are executed based on reason and devoid of individual bias.

Drawing on practical trading encounters to enhance market analysis insights.

Drawing on the insights and tactics learned from experienced traders.

The book by Schwager is a rich source of practical knowledge, informed by his extensive background and discussions with successful traders in the financial markets. He imparts his expertise by detailing 82 key principles and insights, all of which are comprehensively presented in the seventeenth chapter of the book.

The principles cover a range of elements involved in starting trades, deciding when to exit positions, controlling risk exposure, and examining the current state of the market. They provide concrete guidelines for handling various trading situations and highlight common pitfalls to avoid.

For example, he emphasizes the importance of distinguishing between long-term investments and short-term speculative trades, while also carefully planning entry points for positions and determining critical levels for stop-loss orders. He advises against augmenting one's position in trades that are showing a decline. He recommends that traders rely on their intuition, gain insights from their mistakes, and keep a level-headed perspective regarding their transactions in the market.

Continuously enhancing one's strategy by learning from the outcomes of both successful and unsuccessful trades.

Schwager emphasizes the essential need for continuous learning and self-examination. Trading is a fluid and constantly changing endeavor, where those who consistently refine and enhance their strategies often achieve success.

He recommends that investors keep a detailed record of every trade, including the rationale, outcomes, and any lessons learned. Keeping a comprehensive record of all transactions can help identify persistent mistakes, improve trading strategies, and gradually refine the process of making decisions.

Schwager draws a comparison between the ever-changing nature of the market and a flu virus, highlighting its propensity to evolve just when you think you have grasped its behavior. Achieving success in trading necessitates a commitment to continual learning and the flexibility to modify tactics when necessary.

By combining the core tenets of technical analysis with tactical trading approaches and insights into the psychology of trading, as outlined in this book, investors can develop a robust and effective market plan that supports their pursuit of financial goals.

Other Perspectives

• While a systematic and organized approach is beneficial, it can sometimes lead to rigidity, preventing a trader from adapting quickly to unexpected market changes.
• The idea of aligning trading approaches with personal traits assumes a level of self-awareness that many traders may not possess, potentially leading to misaligned strategies.
• Strong risk management strategies are crucial, but overly conservative risk management can result in missed opportunities and suboptimal returns.
• Consistent trading routines are helpful, but they can also lead to a false sense of security, as past routines may not always be applicable to current market conditions.
• Independence in decision-making is important, but collaboration and consideration of expert opinions can sometimes offer valuable insights that an independent view might miss.
• Confidence and patience are key, but overconfidence can lead to complacency, and excessive patience may result in holding onto losing positions for too long.
• Avoiding emotional traps and cognitive biases is easier said than done; emotional responses can sometimes offer intuitive insights that purely rational analysis might overlook.
• Learning from experienced traders is valuable, but blindly following their advice without understanding the context of their success can be misleading.
• Continuous enhancement of trading strategy is important, but constant change can also lead to a lack of consistency, making it difficult to measure the effectiveness of any one strategy.